Higher-ish for a Little Longer-ish

The Federal Open Market Committee (FOMC) held its target for overnight interest rates steady at 5.25% - 5.50% for the sixth consecutive meeting. While markets had, once upon a time, expected rate cuts to commence as early as this spring, persistent upside inflation surprises through early 2024 have caused the Fed to delay the start of an easing cycle. Policymakers are clearly feeling handcuffed by stubbornly high inflation, preventing them from providing the widely anticipated monetary accommodation. For markets that had gotten out over their skis in pricing imminent rate cuts, this FOMC meeting amounts to a hawkish re-set of expectations. As our tongue-in-cheek title suggests, common market parlance has dubbed this re-set “higher or longer,” but higher than what and for longer than what? We are, in all probability, at peak overnight interest rates, and current pricing has those rates holding through almost year-end.

Economic data since the March FOMC meeting has been characterized by solid growth but disturbingly firm inflation. Core 1Q Gross Domestic Product (real final sales to domestic purchasers) ran at a 3.0% pace, with resilient consumer spending offsetting continued weakness in rate-sensitive sectors like housing. The employment backdrop remains very firm, with the unemployment rate holding below 4% and job openings still exceeding available workers by a wide margin. Incoming inflation figures, however, have been persistently higher than expected across a wide range of categories. The PCE inflation metrics accelerated marginally in 1Q, with the core PCE clocking a 4.4% 3-month annualized pace. Most of that is a seemingly anomalous January reading of 0.5%, but the point remains. Services inflation, in particular, has re-accelerated in recent months. While the Fed had been anticipating a faster moderation in inflation, allowing it to cut rates, the higher run rate has caused officials to tap the brakes on policy easing for now. As we are fond of saying, inflation is a process that is only meaningful over time, and so focusing on month-to-month results is not a great way to measure general prices. The PCE results were noisily low in late 2023 and they’ve been noisily high in early 2024, with the trend somewhere in the middle. But the bar for policymakers to act is simply too high for Powell and colleagues to assume away this noise.

Continue to read full PDF